One of the core purposes of retirement planning is to build a diverse portfolio that provides enough income to live on, and in a constantly shifting economy, building that portfolio is a challenging proposition. While there’s no single right way to find an investment mix for your retirement funds, keeping a few guidelines in mind will help you make wise investment decisions.
Risk vs. Reward: The fundamental principle of retirement planning, or indeed any investment planning, is to balance potential risks and potential rewards. As a rule, investing in stocks offers large potential gains, but also big risks, including loss of the principal. Investing in bonds keeps your existing savings safe, but the returns on such an investment are much smaller. As a rule, if you are willing to take on more risk, your portfolio should include more stocks; if you are fairly risk-averse, you should invest in bonds. While personal preference plays a big role in this risk/reward analysis, there are other factors to consider.
Financial Goals: All other things being equal, most investors would like to maximize their income. Retirement planning, however, is all about balancing your current financial obligations with saving for the future. If you plan to retire early, you may need an aggressive mix of investments to bring in enough income to meet that goal. If your retirement plans include world travel or other expensive propositions, then again you will require more income. On the other hand, if you anticipate having fairly fixed expenses during your retirement, securing a reliable income should be your top priority.
Life Stage: If you’re still decades away from retirement, you can afford to take on more high-risk, high-reward investments such as stocks. Even in a worst-case scenario, you have enough time to rebuild your portfolio and bring in enough income to retire. Conversely, if you’re only a few years away from retiring, it’s time to move more and more of your funds to investments that are unlikely to lose value. In the late stages of retirement planning, maximizing income takes a back seat to protecting your savings, as any loss could force you to rethink your post-retirement lifestyle or even outright delay retiring.
Flexibility: Particularly risk-averse investors often like to put their funds in “safe” investments such as bonds. There’s a hidden risk in such investments, however: opportunity cost. If all of your funds are locked up in bonds and interest rates suddenly rise, you’ll find that your portfolio is relatively less valuable. Moreover, if you need to sell off bonds prior to maturity to deal with an unexpected financial need, you’ll lose some of your initial investment. All investments have their inherent risks, and the best way to manage that risk is to diversify your portfolio and maintain some financial flexibility. An all-bond portfolio is almost never a good option; put at least 10 percent of your funds in stocks to keep that flexibility.
Investor Involvement: If you’re serious about preparing for retirement, you’ll need to be at least somewhat involved in the investment process, but the degree of that involvement is up to you. Investing heavily in the stock market requires extensive research, planning and on-the-fly adjustment, which means you’ll either need to put in substantial effort yourself or enlist the services of a professional financial planner. Bonds are significantly more straightforward and require less work on the part of the investor. If you’re not prepared to take an active role in the investments themselves, choose investments that require less of your attention and less adjustment over time.